An Overview of Indian

Financial System
By B. K. VASHISHTHA

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• The term "finance" in our simple understanding it is
perceived as equivalent to 'Money'. We read about
Money and banking in Economics, about Monetary
Theory and Practice and about "Public Finance". But
finance exactly is not money, it is the source of
providing funds for a particular activity. Thus public
finance does not mean the money with the
Government, but it refers to sources of raising
revenue for the activities and functions of a
Government. Here some of the definitions of the
word 'finance', both as a source and as an activity
i.e. as a noun and a verb.

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 INDIAN FINANCIAL SYSTEM
• The economic development of a nation is reflected by the
progress of the various economic units, broadly classified into
corporate sector, government and household sector.  While
performing their activities these units will be placed in a
surplus/deficit/balanced budgetary situations.
• There are areas or people with surplus funds and there are
those with a deficit.  A financial system or financial sector
functions as an intermediary and facilitates the flow of funds
from the areas of surplus to the areas of deficit.  A Financial
System is a composition of various institutions, markets,
regulations and laws, practices, money manager, analysts,
transactions and claims and liabilities.

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Financial System
                                                                                                

                                      

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 Financial System
• The word "system", in the term "financial system",
implies a set of complex and closely connected or
interlined institutions, agents, practices, markets,
transactions, claims, and liabilities in the economy. 
The financial system is concerned about money,
credit and finance-the three terms are intimately
related yet are somewhat different from each other.
Indian financial system consists of financial market,
financial instruments and financial intermediation.

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 FINANCIAL MARKETS
• A Financial Market can be defined as the
market in which financial assets are created or
transferred. As against a real transaction that
involves exchange of money for real goods or
services, a financial transaction involves
creation or transfer of a financial asset.
Financial Assets or Financial Instruments
represents a claim to the payment of a sum of
money sometime in the future and /or periodic
payment in the form of interest or dividend.
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• Money Market- The money market ifs a wholesale debt market for low-
risk, highly-liquid, short-term instrument.  Funds are available in this
market for periods ranging from a single day up to a year.  This market is
dominated mostly by government, banks and financial institutions.
• Capital Market -  The capital market is designed to finance the long-term
investments.  The transactions taking place in this market will be for
periods over a year.
• Forex Market - The Forex market deals with the multicurrency
requirements, which are met by the exchange of currencies.  Depending on
the exchange rate that is applicable, the transfer of funds takes place in this
market.  This is one of the most developed and integrated market across the
globe.
• Credit Market- Credit market is a place where banks, FIs and NBFCs
purvey short, medium and long-term loans to corporate and individuals.

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Constituents of a Financial System

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 FINANCIAL INTERMEDIATION
• Having designed the instrument, the issuer should then
ensure that these financial assets reach the ultimate
investor in order to garner the requisite amount.  When
the borrower of funds approaches the financial market
to raise funds, mere issue of securities will not suffice. 
Adequate information of the issue, issuer and the
security should be passed on to take place.  There
should be a proper channel within the financial system
to ensure such transfer. To serve this purpose, Financial
intermediaries came into existence.

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 FINANCIAL INTERMEDIATION
• This service was offered by banks, FIs, brokers, and
dealers.  However, as the financial system widened
along with the developments taking place in the
financial markets, the scope of its operations also
widened. Some of the important intermediaries
operating ink the financial markets include;
investment bankers, underwriters, stock exchanges,
registrars, depositories, custodians, portfolio
managers, mutual funds, financial advertisers
financial consultants, primary dealers, satellite
dealers, self regulatory organizations, etc.

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 Intermediary Market Role

Stock Exchange Capital Market Secondary Market to

securities
Investment Bankers Capital Market, Credit Market  Corporate advisory services,
Issue of securities

Underwriters Capital Market, Money Market Subscribe to unsubscribed

portion of securities
Registrars, Depositories, Capital Market Issue securities to the investors
Custodians on behalf of the company and
handle share transfer activity
Primary Dealers Satellite Money Market Market making in government
Dealers securities

Forex Dealers Forex Market Ensure exchange ink

currencies

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 FINANCIAL INSTRUMENTS
• Money Market Instruments
• The money market can be defined as a market for short-term money
and financial assets that are near substitutes for money. The term
short-term means generally a period up to one year and near
substitutes to money is used to denote any financial asset which can be
quickly converted into money with minimum transaction cost.
Some of the important money market instruments are briefly
discussed below;
1. Call/Notice Money
2. Treasury Bills
3. Term Money
4. Certificate of Deposit
5. Commercial Papers

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• 1. Call /Notice-Money Market
• Call/Notice money is the money borrowed or lent on
demand for a very short period. When money is
borrowed or lent for a day, it is known as Call
(Overnight) Money. Intervening holidays and/or Sunday
are excluded for this purpose. Thus money, borrowed on
a day and repaid on the next working day, (irrespective
of the number of intervening holidays) is "Call Money".
When money is borrowed or lent for more than a day
and up to 14 days, it is "Notice Money". No collateral
security is required to cover these transactions.
• 2. Inter-Bank Term Money
• Inter-bank market for deposits of maturity beyond 14
days is referred to as the term money market. The entry
restrictions are the same as those for Call/Notice Money
except that, as per existing regulations, the specified
entities are not allowed to lend beyond 14 days.
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• 3. Treasury Bills.
• Treasury Bills are short term (up to one year)
borrowing instruments of the union government. It is
an IOU of the Government. It is a promise by the
Government to pay a stated sum after expiry of the
stated period from the date of issue (14/91/182/364
days i.e. less than one year). They are issued at a
discount to the face value, and on maturity the face
value is paid to the holder. The rate of discount and
the corresponding issue price are determined at each
auction.

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• 4. Certificate of Deposits
• Certificates of Deposit (CDs) is a negotiable money market
instrument and issued in dematerialized form or as a Usance
Promissory Note, for funds deposited at a bank or other eligible
financial institution for a specified time period. Guidelines for
issue of CDs are presently governed by various directives issued
by the Reserve Bank of India, as amended from time to time.
CDs can be issued by (i) scheduled commercial banks excluding
Regional Rural Banks (RRBs) and Local Area Banks (LABs);
and (ii) select all-India Financial Institutions that have been
permitted by RBI to raise short-term resources within the
umbrella limit fixed by RBI. Banks have the freedom to issue
CDs depending on their requirements. An FI may issue CDs
within the overall umbrella limit fixed by RBI, i.e., issue of CD
together with other instruments viz., term money, term deposits,
commercial papers and interoperate deposits should not exceed
100 per cent of its net owned funds, as per the latest audited
balance sheet.

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• 5. Commercial Paper
• CP is a note in evidence of the debt obligation of the issuer. On
issuing commercial paper the debt obligation is transformed into
an instrument. CP is thus an unsecured promissory note
privately placed with investors at a discount rate to face value
determined by market forces. CP is freely negotiable by
endorsement and delivery. A company shall be eligible to issue
CP provided - (a) the tangible net worth of the company, as per
the latest audited balance sheet, is not less than Rs. 4 crore; (b)
the working capital (fund-based) limit of the company from the
banking system is not less than Rs.4 crore and (c) the borrowal
account of the company is classified as a Standard Asset by the
financing bank/s. The minimum maturity period of CP is 7 days.

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 Capital Market Instruments
• Capital Market Instruments
• The capital market generally consists of the following long
term period i.e., more than one year period, financial
instruments; In the equity segment Equity shares, preference
shares, convertible preference shares, non-convertible
preference shares etc and in the debt segment debentures, zero
coupon bonds, deep discount bonds etc.
• Hybrid Instruments
• Hybrid instruments have both the features of equity and
debenture. This kind of instruments is called as hybrid
instruments. Examples are convertible debentures, warrants
etc.

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